Financial Definitions: Margin Definitions

As we continue to look at stock and finance definitions, we come to all those pesky margin definitions. Gross profit? EBIT? Pretax profit? Eek! What do all of these mean? And what do they mean to you? Well let’s take a look!

Gross Profit Margin

To begin, let’s look at the definition of a gross profit margin. Basically, a margin is a defining factor about the company in which you are interested in investing. These neat little numbers can tell you a lot about the strength of a company.

The basic margin, the gross profit margin, is simply a way to express the company’s earnings (income minus expenses) in comparison to its revenue (sales). The percentage that is calculated based on these two items shows you how much profit the company has made after paying out expenses.

EBIT Profit Margin

Going a step further, the EBIT (Earnings Before Interest and Tax) profit margin calculates…you got it, the earnings before interest and tax. This nifty little calculation can get around the tax tricks of the business trade. Where some businesses have found tax loopholes to make their company appear to be profiting more than they actually are, the EBIT cuts through these trickeries to show you the actual profits.

Comparing the EBIT thus allows us, the investors, to better compare companies side by side, even if Company A has a few tax tricks up their sleeve that Company B does not.

Pretax Profit Margin

Finally, we come to the pretax profit margin. This margin is excellent for determining where the company’s profits are trending. The calculation basically finds out how much the pretax earnings amount to as a percentage of total sales, but the numbers can be priceless.

Watching where your company’s pretax profit margin is headed over time can tell you if the company has a strong hold on business matters. For example, a company with a pretax profit margin of 8% that increases over time will generally be a better choice than a company with a decreasing profit margin.

What do the Numbers Mean for Me?

Of course, after all this talk about profit margins, we would be amiss if we failed to mention what the numbers mean. Across the board, higher percentages are normally good.

However, a profit margin comparison is only fair within each industry. For example, comparing Apple to General Mills wouldn’t be a fair margin comparison; the industries are just too different. A better comparison would be General Mills to Kellogg, where the expenditures and sales are much more similar.

Margins are definitely good ways to compare companies, and looking at gross profit, EBIT, and pretax margins can help you decide on your best investment. Of course, make sure to check out the invaluable price to earnings ratio as well!

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